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respondent has no authority to require it to use an inventory
method of accounting when there is nothing on hand at the end of
the day to count. Finally, petitioner argues that the asphalt is
neither merchandise nor an income-producing factor.
Petitioner deducted the cost of the asphalt as a supplies
expense under section 162 and section 1.162-3, Income Tax Regs.
Section 162(a) allows a deduction for "all the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business". Section 1.162-3, Income Tax
Regs., provides in pertinent part:
Cost of materials.--Taxpayers carrying materials and
supplies on hand should include in expenses the charges
for materials and supplies only in the amount that they
are actually consumed and used in operation during the
taxable year for which the return is made, provided
that the costs of such materials and supplies have not
been deducted in determining the net income or loss or
taxable income for any previous year. * * *
The statute and regulations do not define "merchandise" or
"inventory", nor do they clearly distinguish between "materials
and supplies" that are not actually consumed and remain on hand,
and inventory. However, we must decide whether the emulsified
asphalt petitioner uses is a supply within the meaning of section
162 or inventory within the meaning of section 471. We begin by
acknowledging that the authorities in this area are not easily
reconcilable.5
5 See Nolan, “Can the Cash Method of Accounting Clearly
Reflect Income?” Tax Notes 1063 (Feb. 24, 1997) and 1175 (March
(continued...)
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